Enhancing Customer-Supplier Coordination Through Customer-Managed-Inventory

In recent years, there has been an increasing trend in supply chains to employ a “control tower” approach to improve supply chain performance. Such a strategy includes vendor- or supplier-managed-inventory (VMI or SMI) where the supplier takes over the control tower, and the other strategy is customer-managed-inventory (CMI), where the customer takes over the control tower. Although VMI has been extensively examined in the literature, the optimal design of incentive structure of CMI and its impacts on supply chain partners have not been fully explored. To fill the gap, we develop a two-stage supply chain consisting of a supplier and a customer each operating an inventory system with the base-stock policy. Our analyses reveal important demand and operational environments that are conducive for CMI. When demand variation is high, lead time is long, and the supplier is not as much concerned with the negative consequences of having shortages as the customer, CMI can bring significant gains to the entire supply chain. Achieving the potential gains, however, will require suitable incentive mechanisms including certain cost-sharing schemes and adjustment to the wholesale price. We find that the customer’s share of the supplier’s inventory and shortage costs should be determined jointly to maximize the expected total benefit for the supply chain, and then they should re-negotiate the wholesale price in such a way that the total benefit is split between them depending on their negotiating power. Furthermore, we find that these results are robust under various extensions